GST Applies to Liquidated Damages Received Under Arbitral Awards, Rules AAR
Maharashtra AAR ruled that liquidated damages awarded for contract termination are subject to GST as a service of tolerating an act.
- Ruling
- NO.GST-ARA- 07/2018-19/B- 63 dated 11.07.2018
- Dated
- 11 Jul 2018
- Authority
- Authority for Advance Ruling
This page was written by Patron Accounting’s AI from the official release and reviewed before publishing. It explains the document in plain language. It is not the document itself. Where this page and the original differ, the original governs.
The short version
- Company claimed damages after terminating a contract for unpaid invoices
- AAR ruled liquidated damages are taxable under GST as tolerating an act
- GST liability arises after the arbitration award is officially pronounced
- Tax applies to the actual amount received under the award
In short
A technical consultancy firm cancelled its contract after the client failed to pay invoices and claimed liquidated damages through international arbitration. The company asked the tax authority whether receiving liquidated damages or compensation under an arbitral award attracts Goods and Services Tax (GST).
What has changed
How it worked before
Many businesses assumed that breach of contract damages or court-ordered compensation were penalties rather than payments for services, and were therefore outside the scope of GST.
What has changed
The Maharashtra Authority for Advance Ruling (AAR) decided in order NO.GST-ARA- 07/2018-19/B- 63 Mumbai that receiving compensation for a broken contract counts as tolerating an act, making it a taxable supply under GST. GST becomes payable on the actual amount received under the award once decided. However, readers should note that CBIC Circular No. 178/10/2022-GST later clarified that standard contract breach damages are generally not taxable unless a specific service agreement to tolerate exists.
Who this affects
Businesses that enter into commercial contracts with penalty clauses, compensation terms, or damages awarded through arbitration.
An example
A software company in Maharashtra signs an agreement to build a custom application for a buyer. The buyer defaults on payments, so the software company terminates the contract and wins an arbitral award of 20 lakh rupees as liquidated damages. Based on the logic in this ruling, the software company would have to pay GST on the 20 lakh rupees actually received because it tolerated the buyer's failure to perform. However, subsequent government circulars offer different guidance for simple contract breaches.
What you should do
An advance ruling binds only the specific business that applied and its local tax authority. You should not assume this ruling automatically applies to your contract. Review your terms with a tax professional and consider filing your own application if your tax position is unclear.
If you do nothing
If you rely on another company's advance ruling without assessing your own situation, your tax officer might take a different view during an audit. If the department concludes that your compensation was taxable and you did not pay GST, they can demand the unpaid tax with interest and penalties. Defending your position can lead to expensive tax litigation.
The terms explained
- liquidated damages
- A fixed or calculated sum of money that one party pays to another if a contract clause is broken or terminated.
- input tax credit
- The GST a registered business pays on its business purchases, which it can use to reduce the GST owed on its sales.
- tolerating an act
- A GST concept where agreeing to suffer or permit someone's breach or failure is treated as providing a service to them.
The ruling in detail
Authority for Advance Ruling
M/s. North American Coal Corporation India Private limited
NO.GST-ARA- 07/2018-19/B- 63 dated 11.07.2018 · Maharashtra
Questions before the authority
- Whether liquidated damages that may be awarded to the Applicant by the International Chamber of Commerce ("ICC") qualifies as a 'supply' under the Goods and Services Tax ("GST") law, thereby attracting the levy of GST?
- If the answer to Question No. 1 is in the affirmative, what should be the time of supply, that is to say, the point of time in which NACC's liability to pay GST arises?
- If the answer to Question No. 1 is in the affirmative, what should be the value of supply on which GST is payable, that is to say, whether the Applicant is liable to pay GST on amount of liquidated damages claimed and awarded to the Applicant under the arbitral award or the amount which is actually received by the Applicant after conclusion of the matter before the final Appellate authority?
Facts
The applicant entered into an Association Agreement to provide technical consultancy and operations support for a power project. Following non-payment of invoices by the service recipient, the applicant terminated the agreement under contractual default clauses and claimed liquidated damages and reimbursement of expenses. The dispute was referred to international arbitration before the International Chamber of Commerce (ICC) in London, prompting the applicant to seek an advance ruling on the taxability of any arbitral award or damages received.
Ruling
| Question | What the authority ruled |
|---|---|
| Taxability of liquidated damages awarded by ICC | Affirmative Qualifies as a supply of service under Section 7(1) read with Schedule II Entry 5(e) as agreeing to tolerate an act. |
| Time of supply for liquidated damages | Determined as per Section 13 of the CGST Act Liability arises after the arbitration award is pronounced by the ICC tribunal. |
| Value of supply for liquidated damages | Actual amount of damages received Based on the actual liquidated damages cum consideration awarded and received from the defaulting party. |
The Authority held that liquidated damages or compensation awarded by the ICC for default or breach of contract qualify as consideration for **tolerating an act or situation**, making it a taxable supply of service under Section 7(1) read with Schedule II Entry 5(e) of the CGST Act. The time of supply is to be determined under Section 13 of the CGST Act after the arbitral award is pronounced by the tribunal. The value of supply will be the **actual amount of damages received** by the applicant pursuant to the award.
Reasoning
The Authority examined the contractual terms (Articles VI, VIII, and XII of the agreement) and concluded that the contract explicitly foresaw default, termination, and payment of damages. It reasoned that the agreement created a mutual understanding to foresee and **tolerate an act of default** for monetary consideration. Consequently, compensation or liquidated damages paid upon breach or termination fall directly within the scope of Entry 5(e) of Schedule II of the CGST Act ('agreeing to the obligation to refrain from an act, or to tolerate an act or a situation').
Provisions relied on
- Section 7(1) of the CGST Act, 2017
- Section 9(1) of the CGST Act, 2017
- Section 13 of the CGST Act, 2017
- Section 15 of the CGST Act, 2017
- Schedule II Entry 5(e) of the CGST Act, 2017
For the practitioner
This order reflects the early stance of advance ruling authorities treating liquidated damages for contract breach as a taxable supply of service under the rubric of **agreeing to tolerate an act**. Tax practitioners should note that this positional interpretation was subsequently countermanded by CBIC Circular No. 178/10/2022-GST, which clarified that breach of contract damages are not consideration for tolerating an act unless there is a specific independent agreement to tolerate.
Source
This is a summary prepared from the published order, which is a scanned document. It is a reading aid and not the authority: where the two differ, the order governs. Verify every provision against the original before relying on it.
Original order: https://www.gstcouncil.gov.in/sites/default/files/AAR/maha-gst-ara-07-b-63_dt._11.07.18_naccipl.pdf
Legibility of the scan, as read: high.
Prepared 20-10-2026.
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